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Cayman Captive Forum Presentation 2013. Captive / Actuarial 101. Julie E. Robertson Partner. Joseph A. Herbers Managing Principal. Fiona J. Moseley President & Director.

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Presentation Transcript
slide2

Julie E. Robertson

Partner

Joseph A. Herbers

Managing Principal

Fiona J. Moseley

President & Director

slide3

" Everything you wanted to know and were afraid to ask… An introductory session to cover practical guidelines on legal, actuarial and regulatory matters during the formation and operational stages of a new captive."

what is a captive
What is a Captive?
  • The most simple definition: a licensed insurance company formed to insure the risks of its owners

But the world is more complicated

        • RRGs; cell companies (SPCs), agency captives, rent-a-captives, micro captives, branch captives, reciprocals, series LLCs, portfolio insurance companies (PICs)
  • If you’ve seen one captive . . . you’ve only seen one captive!
  • Array of models provides flexibility, but creates the need for expertise and evaluation of the options in formation
what is a captive1
What is a Captive?
  • A licensed insurance company
  • Regulated in a state or country (domicile) that has unique laws for captives
        • They typically vest a great deal of authority in the regulator and are less stringent than laws regulating commercial carriers
  • Owners/insureds involved in governance
  • Often have no employees but are managed by contracted service providers
captive feasibility studies outline
Captive Feasibility Studies - Outline
  • What is a Captive Feasibility Study
  • What are Actuaries?
  • Actuarial Involvement in Captive Feasibility Study
  • Dealing with Uncertainty
  • Predicting the Future
captive feasibility studies
Captive Feasibility Studies
  • Data Analysis
  • Loss Estimates
  • Capitalization Requirements
  • Domicile
  • Tax Issues
  • Coverages, Retentions, Limits
  • Expenses
  • Reinsurance Costs
  • Regulatory Issues
  • Pro forma Financials
actuaries captive feasibility studies
Actuaries & Captive Feasibility Studies
  • Projecting the future as regards:
    • Premiums
    • Losses
    • Loss Adjustment Expenses
    • Captive expenses
      • Acquisition, general, taxes
      • Reinsurance costs
  • Capitalization Requirements
  • Investment Returns
what is an actuary
What is an Actuary?
  • Insurance professional skilled in measuring and quantifying risk
  • Typically a math or statistics major in college
  • Schooled in all aspects of insurance operations

- Claims - Accounting

- Underwriting - Ratemaking

- Marketing - Reinsurance

- Legal - Systems/IT

what does an actuary do
What does an Actuary do?
  • Quite simply – Predict the Future
  • Ratemaking – Figure out what premiums to charge for variety of coverages, limits and deductibles
  • Loss Funding Studies – Projecting future costs so insurer or self-insured entity can budget costs
  • Loss and loss adjustment expense reserve accruals for financial reporting purposes
  • Retention Level Analysis
  • Exposure Modeling (CAT)
  • Risk Transfer in Reinsurance
essential background information
Essential Background Information
  • Business Plan
  • Historical premium, losses, claim counts & exposures for entity being considered
  • Domicile, Service Providers being considered
captive business plan
Captive Business Plan
  • Key management of enterprise
    • Owner(s), officers, roles
  • Nature of underlying business being insured
  • Coverages
  • Retentions - both per occurrence and aggregate
  • Limits
  • Service Providers
data analysis
Data Analysis
  • Projecting Ultimate Losses
    • Start with current reported incurred losses
      • Adjust for retentions
      • Adjust for expected future loss development
      • Adjust for future trend
      • Adjust for changes in statutory benefit levels (WC)
    • Use multiple methods to project ultimate losses
    • Rely on a point estimate or reasonable range of ultimate losses
  • Project Ultimate Loss Ratio
slide16
Lags
  • Projecting Ultimate Losses
    • Start with current reported incurred losses
      • Adjust for retentions
      • Adjust for expected future loss development
      • Adjust for future trend
      • Adjust for changes in statutory benefit levels (WC)
    • Use multiple methods to project ultimate losses
    • Rely on a point estimate or reasonable range of ultimate losses
  • Project Ultimate Loss Ratio
  • Property/Casualty insurance business is characterized by lags (which give rise to need for IBNR)
uncertainty in projecting ultimate losses
Uncertainty in Projecting Ultimate Losses
  • Changes in rate of claim payments
  • Changes in case reserving practices
  • Changes in mix of exposure
  • Changes in retention limits
  • Changes in claim reporting procedures
data analysis1
Data Analysis
  • Projecting Expenses
    • Commissions/Brokerage
    • Fronting
    • Taxes, Licenses & Fees
    • General (audit, actuarial, legal)
    • Claims Handling
    • Reinsurance
    • Loss Control
    • Federal Excise Tax

Usually stated as % of either WP or EP

data analysis2
Data Analysis
  • Underwriting Profit
  • Investment Returns
    • Investment Income
      • Mix of investments by type (stocks, bonds, cash, other)
      • Expected returns by type
    • Realized Capital Gains/Losses
  • FIT
  • Dividends
pro forma financials run pessimistic base and optimistic scenarios
Pro Forma FinancialsRun Pessimistic, Base and Optimistic scenarios
  • Underwriting Exhibit
    • Projected premiums (direct / ceded / net)
    • Projected losses (premium x loss ratio)
    • Projected expenses
    • Dividends
    • Underwriting profit (by subtraction)
  • Balance Sheet
    • Assets, Liabilities & Surplus
pro forma financials run pessimistic base and optimistic scenarios1
Pro Forma FinancialsRun Pessimistic, Base and Optimistic scenarios
  • Income Statement
    • Underwriting Income, Investment Income, Other Income
    • Change in Surplus
      • Beginning Surplus
      • Capital Paid In
      • Net Income
      • Change in unrealized gains
      • Stockholder dividends
  • Cash Flow Statement
    • Beginning Cash
    • Inflows (premiums, investment income, paid-in capital)
    • Outflows (losses, expenses, taxes, dividends)
consideration of uncertainty
Consideration of Uncertainty
  • Reliance on actual data versus benchmarks and/or external data – less uncertainty if we have reliable data for entity being studied
  • Nature of historical data (# of years, consistency between years)
  • Examine reasonable range versus point estimate
predicting the future
Predicting the Future
  • We know our projections will not be absolutely correct
  • Objective is to have projections “in the right neighborhood” close to reality
  • Systematic pessimism or optimism is not good
  • With feasibility studies, we provide a range from pessimistic to optimistic
captive models
Captive Models

Single Parent Captive

Wholly owned insurance company established to insure/reinsure the risks of the single parent and/or its affiliates.

SINGLE PARENT NO AFFILIATES:

COMPANY X

Insurance

CAPTIVE

captive models1
Captive Models

SINGLE PARENT CAPTIVE SERVING AFFILIATES:

COMPANY X

CAPTIVE

COMPANY X

Subsidiary 1

COMPANY X

Subsidiary 2

COMPANY X

Subsidiary 3

captive models2
Captive Models

Group Captive

Two or more owners form an insurance company to insure/reinsure risks of its owners (or their affiliates)

GROUP CAPTIVE:

COMPANY X

COMPANY Y

COMPANY Z

CAPTIVE

captive models3
Captive Models

Cell Captive (aka Segregated Cell Captive, Sponsored Captive, Segregated Portfolio Company)

One insurance company with separate “cells,” each cell with a separate insurance program and possibly a shareholder.

Ownership of Voting Stock of

the Captive, Appoints Board

Preferred X Shares

CAPTIVE

Cell X

Cell Y

Cell Z

Preferred Y Shares

Preferred Z Shares

captive models4
Captive Models

Risk Retention Group

Similar in structure to a group captive, but formed in a U.S. state under authority of Liability Risk Retention Act. All insureds must be owners, and all owners must be insureds – only authorized to write liability risk.

COMPANY X

COMPANY Y

COMPANY Z

RISK RETENTION GROUP

domicile selection
Domicile Selection

Other factors

Capital/surplus requirements

Operating costs

Political stability

Infrastructure

Domicile meeting requirements

Local director requirements

Operating costs

Ease of travel

Perception, particularly for nonprofits

Availability of home state as a domicile

Unique characteristics of the domicile

  • Driving factors
    • Structure/Coverage Needs
    • Regulatory environment; history
    • Tax considerations
      • Onshore and offshore
      • Premium taxes
slide30
Tax
  • From the insured’s perspective
      • Is the premium deductible?
      • What are the premium taxes?
          • Domicile, US federal excise tax, state premium taxes
  • From the owners’ perspective
      • If offshore, are the owners subject to tax annually or only when distributions are made?
      • If offshore, is there “unrelated business taxable income” for the tax-exempt owners
slide31
Tax
  • From the captive’s perspective
      • Is it an insurance company for US tax purposes (ie, can deduct its loss reserves)?
      • If offshore, is it eligible to elect to be a US corporation for tax purposes (a 953(d) election)?
      • Is it eligible for a small company election (an 831(b) election)?
      • If offshore, are there withholding taxes on its income?
      • If offshore, controlled foreign corporation or not?
      • If offshore, does it intend to “conduct a U.S. trade or business”?
      • Are there opportunities for the captive to be a tax-exempt entity?
slide32
Tax

What’s most important:

  • Understand that taxable and tax-exempt organizations may have different tax motivations
  • Recognize that there is not certainty in this area and determine owners/insureds’ risk tolerance
  • Determine tax positions up front, not when returns are prepared
  • Make sure all stakeholders’ tax advisors are involved at the beginning
  • Document the business reasons for captive formation as support in case of future audit
  • Include tax calculations in pro formas and projections
direct write or fronted program
Direct Write or Fronted Program?
  • A captive typically is not licensed/approved/admitted in the jurisdiction in which the insureds are located and is treated as an “unauthorized insurer”
  • Can the captive write coverage directly or does it need a “front”?
      • State legal and regulatory requirements
      • Contractual requirements of insureds
      • Patient compensation funds
  • Does the captive intend to attract new insureds/have a desire to market the program?
formation
Formation
  • Legal documents for formation:
      • US: Articles of Incorporation/Bylaws
      • Cayman: Memorandum of Association/Articles of Association
  • Other legal documents:
      • Shareholders agreement for group captives
      • Information circular/offering documents for group captives
      • Subscription agreement
  • License Application:
      • Pro formas
      • Actuarial projections
      • Business plan
      • Identification of service providers
      • Applications of directors and officers
initial operations
Initial Operations
  • Approval in principle sparks a flurry of activity
  • Put in place operational guidelines
  • Board of Directors guidance
  • Front Company and Reinsurance
  • Insurance Manager
  • Committees
  • Regulatory
approval in p rinciple s parks a flurry of a ctivity
Approval in Principle Sparks a Flurry of Activity
  • Incorporation
  • Subscribers Meeting
  • First Directors Meeting
  • Open Bank Account
  • License issued
put in place o perational g uidelines
Put in Place Operational Guidelines
  • Board of Directors
  • Front company
  • Reinsurers
  • Insurance Manager
  • Committees
      • Claims Management, Audit and actuarial, investment etc.
getting up and running
Getting Up and Running
  • Approve insurance arrangements
  • Engage service providers
      • Actuary, auditor, lawyer, investment manager, banker, insurance manager
  • Adopt operating budget
  • Approve investment policy
  • Other policies: claims payment, expense reimbursement

Congratulations: You’re running an insurance company!

board of directors g uidance
Board of Directors Guidance
  • Frequency of meetings, circulation of contact details and agreement of approval mechanism
  • Understand business plan and laws of operation
  • Mind and Management discussion

– who is driving the bus and from where?

  • Discuss and declare any conflicts and process around future conflicts
  • Appointment of Secretary and define role
  • Mandates for Committees
  • Signing Authority
corporate governance
Corporate Governance
  • Role of the Shareholders
  • Role of the Directors
  • Role of the Officers
  • Directors Duties
      • Fiduciary
      • Duty of care and skill
      • Minutes
      • Meetings
      • Engagement and oversight of service providers
front company and reinsurance
Front Company and Reinsurance
  • Review and sign agreements
  • Confirm logistics and reporting
insurance manager
Insurance Manager
  • Confirm responsibilities and expectations
  • Reporting deadlines
  • Information exchange
  • Financial Statement prep, Actuarial and Audit
  • Who is driving the bus?
committees
Committees
  • Define make-up
  • Adopt the mandate
  • Review the business plan
regulatory
Regulatory
  • 6 month check up
  • Financial Statement submission
  • Conformity to Business Plan
  • What if something go wrong?
success factors
Success Factors
  • Taking the long view
  • Management commitment
  • Adequate funding and capitalization
  • Group captives: documentation and fairness
  • Focus on risk management and mitigation
  • Conservatism in the early years